The Kiddie Tax and How to Avoid It

The kiddie tax was enacted by Congress to prevent parents from passing investment income to their children, typically those with a lower tax rate. Under the kiddie tax rules, a portion of a child’s net unearned income may be taxed at the parent’s marginal federal income tax rate. The kiddie tax applies to children up to age 24, assuming they meet certain criteria.

The kiddie tax can result in higher taxes on an affected child’s net unearned income than otherwise would apply. For example, if a child’s net unearned income exceeds the annual threshold of $2,500 for 2023, the portion of the income exceeding the threshold is subject to the kiddie tax.

The kiddie tax does not apply if the child’s net unearned income for the year remains below the threshold for that year.

There are four criteria that apply to the kiddie tax

These criteria include:

• The child not filing a joint return for the year,
• at least one parent being alive at year’s end,
• the child’s net unearned income for the year exceeding the threshold for that year,
• and the child not meeting the specific age rules

With these rules in mind, there are several strategies to limit the kiddie tax’s impact on your child’s unearned income.

Exploit the unearned income threshold

Manage your child’s unearned income to ensure it remains below the annual threshold.

Pick the right investments

You can reduce unearned income by selecting investments with minimal or no dividends, such as growth stocks or tax-efficient mutual funds.

Invest in Series EE U.S. Savings Bonds

The accumulated interest income from these bonds is tax-deferred until cashed in. Therefore, no kiddie tax applies if the bonds are cashed in when the child is exempt from the kiddie tax.

Use a Section 529 College Savings Plan

Withdrawals from a Section 529 plan account are federal-income-tax-free, provided they’re used for qualifying education expenses.

Invest in Life Insurance Products

Investment accounts included in life insurance products such as universal life policies allow tax-deferred accumulations and can be borrowed against for college costs.

Generate Earned Income

The kiddie tax does not apply to children aged 18-23 if their earned income exceeds 50 percent of their support for the year.

How We Can Help

Sterling Tax and Accounting is here to help your business with tax planning!  Our comprehensive approach to tax planning helps reduce your overall tax liability and keep more money in your pocket.  If all your accountant does is file your taxes, chances are they are making you pay more than your fair share of taxes.

Learn how to proactively save on taxes by scheduling a call with our tax planning specialists.

Our tax planning, accounting & business services help you stay on track. Sterling Tax & Accounting will work with you to optimize your business and minimize your taxes. We will work to provide you and your business with the tools and resources you need to build a solid tax and business foundation. We’re a trusted CPA Firm in Sarasota, Florida. We serve clients all over the US, and proactively work to minimize their taxes.

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